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Economic integration and the optimal corporate tax structure with heterogeneous firms

  • Christian Bauer

    (University of Munich)

  • Ronald B Davies

    (University College Dublin)

  • Andreas Haufler

    (University of Munich)

We study the optimal combination of corporate tax rate and tax base in a model of a small open economy with heterogeneous firms. We show that it is optimal for the small country's government to effectively subsidize capital inputs by granting a tax allowance in excess of the true costs of capital. Economic integration reduces the optimal capital subsidy and drives low-productivity firms from the small country's home market, replacing them with high-productivity exporters from abroad. This endogenous policy response creates a selection effect that increases the average productivity of home firms when trade barriers fall, in addition to the well-known direct effects.

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File URL: http://www.ucd.ie/t4cms/WP11_15.pdf
File Function: First version, 2011
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Paper provided by School of Economics, University College Dublin in its series Working Papers with number 201115.

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Length: 39 pages
Date of creation: 23 Aug 2011
Date of revision:
Handle: RePEc:ucn:wpaper:201115
Contact details of provider: Postal: UCD, Belfield, Dublin 4
Phone: +353-1-7067777
Fax: +353-1-283 0068
Web page: http://www.ucd.ie/economics

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